The ﬂow-to-equity approach has been used by the ﬁrm to value their capital budgeting projects. The total investment cost at time 0 is €640,000.The company uses the ﬂow-to-equity approach
Because they maintain a target debt to value ratio over project lives.The company has a debt to
Equity ratio of 0.5.The present value of the project including debt ﬁnancing is €810,994.What is the
Closest relevant initial investment cost to use in determining the value of the project?

Question

Quizplus · Accepted Answer

The flow-to-equity approach involves determining the cash flows available to equity holders after debt payments have been made. Therefore, the present value of the project including debt financing already accounts for the debt portion of the investment cost. To determine the relevant initial investment cost, we need to subtract the present value of debt financing from the total investment cost at time 0.

PV of debt financing = €810,994 - €640,000 = €170,994

Relevant initial investment cost = Total investment cost - PV of debt financing 
= €640,000 - €170,994 
= €469,006

Out of the answer choices, the closest relevant initial investment cost is €372,372 (Option C).

The ﬂOw-To-Equity Approach Has Been Used by the ﬁRm to Value